Despite increased revenue, NetJets’ profits disappear

When Berkshire Hathaway chairman Warren Buffett speaks, everyone listens. As usual, he spoke aplenty in his latest annual letter to shareholders, which was released early last month.

In his shareholder letter and accompanying annual report for Berkshire Hathaway, the “Oracle of Omaha” got down to the nitty-gritty financial details of its many divisions, one of them the flight- services division. Buffett said this division, which includes flight-training company FlightSafety International and fractional provider NetJets, stumbled a bit last year, reporting $120 million in pre-tax profits versus $191 million in 2004, despite higher revenues of $416 million, a 13-percent increase over 2004.

Both NetJets and FlightSafety contributed equally to last year’s revenue increase, with each company posting 13-percent revenue gains over the previous year. For NetJets, this revenue increase pales in comparison with 2004, when the fractional provider was responsible for more than 90 percent of the year-over-year revenue improvement.

Last year, NetJets’ revenues were helped by an 18-percent jump in flight operations and management service fees, as well as by higher flight operations revenue that primarily resulted from a 7-percent increase in occupied flight hours, rate increases and a higher mix of large-cabin aircraft usage.

FSI in the Black, NetJets Dips into Red

According to Buffett, “Earnings improved at FlightSafety as corporate aviation continued its rebound.” Overall, pre-tax profits last year at FlightSafety increased by about 10 percent over 2004 to approximately $200 million, which Berkshire’s annual report attributes to increased training revenues and simulator sales.

But, Buffett said, “Operating results at NetJets were a different story. I said last year that this business would earn money in 2005–and I was dead wrong.” In fact, the annual report shows that NetJets incurred a pre-tax loss of about $80 million last year compared with pre-tax income of about $10 million in 2004.

Several factors contributed to the loss at NetJets last year. The report indicates that NetJets experienced “unusually high shortages of available aircraft due to increases in owner demand outpacing increases in capacity,” most likely the result of increased flying by fractional owners and surging jet-card usage.

Therefore, NetJets subcontracted additional aircraft capacity through charter operators, which came at a high price. “The costs associated with subcontracted flights were not fully recoverable from clients and caused an incremental pre-tax cost of approximately $85 million in 2005,” the report said. “NetJets has added aircraft to the core fleet and is developing strategies to address capacity issues and restore profitability.”

Further, NetJets recorded a special charge of $20 million in the fourth quarter for prior periods’ compensation related to a new labor contract with its pilots and flight attendants. Additionally, interest expense last year increased approximately $23 million due to higher interest rates.

“Despite a large increase in customers…our U.S. operation dipped far into the red,” noted Buffett. “Its efficiency fell, and costs soared. We believe that our three largest competitors [Flight Options, Flexjet and CitationShares] suffered similar problems.”

But the news at NetJets wasn’t all bad. Buffett said NetJets’ “European operation…showed both excellent growth and a reduced loss. Customer contracts there increased by 37 percent. We are the only fractional-ownership operation of any size in Europe.”